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Appeal of an Insider Violation for Preferential Treatment - (First Quarter 2002)


A bank appealed a violation of 12 USC 375b and 12 CFR 215.4(a)(1)(i) cited in the bank's Report of Examination (ROE) in connection with a loan extended by the bank to a director.  Bank management believed the facts associ­ated with the transaction did not represent preferential terms on the credit extended to the insider.  The transaction involved the refinancing of an automobile loan from the insider's business to the insider personally.

The loan to the business was at the bank's prime rate for commercial customers plus 100 basis points and was structured on an interest-only time/demand note.  When the loan was refinanced into the individual's name, the borrower paid down over 40 percent of the outstanding balance, and received the going installment loan rate for a 48 month auto loan, approximately 200 basis points less than the previous loan.  However, the loan was left on an interest-only time/demand note, maturing in 12 months with quarterly interest payments.  An analysis of the finan­cial information supported the borrower's credit worthi­ness with minimum debt, strong net worth, and good liquidity.

The bank's rate sheet detailed separate rates for loans structured on an installment basis versus those on a time/ demand basis.  The supervisory office cited the violation because management granted the lower installment loan rate for a loan secured by a 1999 automobile for a 48 month term, not the higher time/demand rate listed on the bank's rate sheet.  The supervisory office position was that an installment loan rate should only be applicable for loans actually on an installment basis with monthly or quarterly principal and interest payments.  During the ex­amination, bank management was not able to provide any acceptable transactions that were comparable in pricing and structure to demonstrate that the terms extended to the director were also available to other non-insider cus­tomers of the bank.


Regulation O, 12 CFR 215, ''Loans to Executive Officers, Directors, and Principal Shareholders of Member Banks,'' section 215.4(a) (1) (i), states:

(1) No member bank may extend credit to any insider of a bank or insider of its affiliates unless the extension of credit:

(i)   Is made on substantially the same terms (includ­ing interest rates and collateral) as, and following credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions by the bank with other persons that are not covered by this part and who are not employed by the bank.

The bank provided the ombudsman with an example of a similarly structured loan that was granted to a non-insider to demonstrate that the time/demand structure of the loan was available to other customers of the bank.  The om­budsman found the loan to the non-insider was extended before the insider's loan and the pricing methodology and the structure were consistent for both transactions, al­though other terms varied slightly.


The ombudsman found the bank's loan rate sheet to be ambiguous and determined that it could be interpreted in various ways.  It did not clearly specify whether the rate should be based on the collateral or structure.  According to the rate sheet:

  • The rate on personal loans was determined by the col­lateral; in this case rates for the collateral (1999 ve­hicle) were 7.50 percent for 36 months, 7.75 percent for 48 months, and 7.90 percent for 60 months.
  • The rate on time/demand loans was prime rate (9.50 percent) plus 50 or 100 basis points, even when se­cured by deposits in the bank.

As shown above, it would not be clear which rate should be applied on a personal loan, with an automobile as collateral and structured on a time/demand basis. Considering all the above, the ombudsman did not be­lieve the loan in question represented preferential treat­ment for an insider and thus it was not a violation of 12 CFR 215.4.  While the bank was able to provide a compa­rable transaction, that was not the basis for the ombuds­man's conclusion. Directors' business and personal dealings with the bank must be structured to comply with legal requirements and to avoid even the appearance of a conflict of interest. The ombudsman encouraged bank management and the board to thoroughly review and revise the bank's rate sheet so that all ambiguities are eliminated.